Educational Articles

Stock Screen: Financial Strength Rating Changes - April 4, 2014

Alan House
| April 04, 2014

Value Line assigns Financial Strength ratings across a spectrum from A++ (Highest) to C (Lowest). Generally speaking, the largest companies with the strongest balance sheets get the highest scores. Factors considered in making a rating determination include balance sheet strength, corporate performance, market capitalization, stability of returns, and business outlook, among others.

The Financial Strength rating and a stock’s Price Stability rank are the two main components used to determine Value Line’s proprietary Safety Rank, which measures the total risk of a stock relative to the approximately 1,700 other stocks under Value Line review.

Although a company’s Financial Strength rating is just one factor among many that investors should consider, it is an important one. Moreover, shareholders should take particular note of changes in this rating—both up and down. Value Line subscribers have access to our complete list of Financial Strength upgrades and downgrades each week in the Selection & Opinion section of the product. Noted here, however, are recent upgrades awarded to ARM Holdings plc (ARMH) and Corning, Inc. (GLW).

ARM Holdings plc

ARM designs microprocessors, physical IP and related technology software, and sells development tools to enhance performance, cost-effectiveness, and energy efficiency of high-volume embedded applications. It licenses and sells technology to electronics companies to be manufactured into application-specific integrated circuits (ASICs).

ARM Holdings has strong growth opportunities for both this year and next, based on our financial model. The impending adoption of the company’s 64-bit chip in some of the most highly promoted technology products in the marketplace gives us increased optimism. Essentially all of the major players in the smartphone market are clients of ARM, and intend on upgrading from 32-bit microprocessors in the near term. The semiconductor designs have already been used in the popular iPhone 5S, a product whose speed and processing ability have been well documented. Furthermore, the fact that this year marks the introduction of the first generation of headsets to incorporate this design, gives us confidence in our 18- to 24-month earnings expectations.

We are optimistic regarding ARM’s 3- to 5-year revenue and earnings projections. As more products become “smart”, and tech items gain momentum in previously untapped segments, the market for the company’s products should expand nicely. And, given a hefty investment in research and development, which has enabled the company to churn out successful new technologies, we look for it to remain at the head of the pack going forward. ARM has a dominant market share in the smartphone segment and we don’t look for it to relinquish control anytime soon.

ARM has strong financials, too, as it has no debt on the ledger, while cash on the balance sheet continues to climb. What’s more, increased profits are poised to boost cash from operations over the 3- to 5-years ahead. As such, we have raised the company’s Financial Strength rating from B++ to A.

Corning, Inc.

Corning operates in five segments: Display Technologies, Optical Communications, Environmental Technologies, Life Sciences, and Specialty Materials. The company completed the acquisition of Samsung Corning Precision Materials this year. It owns a 50% interest in silicone product maker Dow Corning.

The company’s share price has enjoyed a nice run-up in recent times, thanks to brightening prospects. At a recent investor meeting, management outlined a vision to continue its earnings gains through ongoing innovation, and also stated that the integration of Samsung Corning, which was acquired earlier this year, might well add approximately $2 billion to the top line. Meantime, this value-oriented stock has gained considerable ground following the agreement with Samsung.

We continue to look for solid annual earnings gains, on average, long term. Though both Optical Communications and Display earnings declined in the December period, these units have ample room to improve, from our perspective. (The company recently changed the Telecommunications segment to Optical Communications to promote its increased emphasis on optical fiber.) Though Optical sales improved, a less profitable product mix led to the profit decrease. Furthermore, the Display segment should register an increase in volumes this year, but pricing might remain difficult. However, over the 3- to 5-year pull, we look for both segments to benefit from increased operating leverage, which should translate to healthy companywide earnings gains.

We look for Corning to be active on the share-repurchase front. The company announced a $1.25 billion buyback program in March. Given increased cash flow from operations, we look for management to pare its share count over the next couple of years. This should help support bottom-line gains over that period.

Corning has solid finances, as debt-to-total capital is at a healthy level (13%), while cash on the balance sheet is in excess of $5.2 billion. These factors, among others, has prompted us to raise the company’s Financial Strength rating by a notch, to B++.

At the time of this article's writing, the authors did not have positions in any of the companies mentioned.